Post Card from Cyprus

When Swen asked me to get down to Cyprus to cover the olive harvest I thought this would be a dull assignment.

But since arriving on Aphrodite’s enchanted island, I now understand that this country is a living case study in Eurozone post-bailout recovery. Let me explain.

Cyprus is the most Easterly country in Europe. As I write, I am but a few pigeon flaps away from Alexandria, the historic capital of Egypt. The Holy Land is a four hour boat ride. Surrounded by the land masses of Asia and Africa, geographically, this is hardly Europe at all.

Since 1974, this beautiful island has been dissected by a barbed wire fence which divides the Turkish north from the Greek south. With the help of field glasses, I can spy a huge Turkish flag cut into the hillside above Morphou Bay. One has to be careful not to incur exorbitant Turkish roaming charges if one strays into an area served by Turkish telephone networks – easily done.

So actually, Greek Cyprus is half a country clinging desperately to the EU (and the Eurozone) to assure its precarious existence. Although, thankfully, relations between the two halves of the island are more cordial than previously. The border is open at specific checkpoints and trade between the two mini-states is brisk; and there is talk that a major breakthrough is imminent (nothing new about that though).

The Russians are still here in force. The Greeks and the Russians share the Orthodox church and a love of icons. And the climate here beats Moscow. The tragic downing of a Russian passenger jet over Sinai on 31 October will probably mean that, in the near future at least, even more Russians will choose Cyprus for their vacation in preference to Egypt.

The Republic of Cyprus (Greek Cyprus) joined the EU on 01 May 2004. Turkish Cyprus was excluded, much to its chagrin, for political reasons. (Is The Turkish Republic of Northern Cyprus really a state at all or a province of Turkey? Nobody recognises it as a state, except Turkey.) So Greek Cyprus came in with the crew of ex-communist Eastern European states – Poland, Hungary and the rest. Plus a fellow Mediterranean island nation which is also a Commonwealth member – Malta.

A high-income economy with a very high UN Human Development Index, Cyprus gained fast-track admission to the Eurozone on 01 January 2008. For a while, everything went swimmingly. Low interest rates in the Eurozone and a booming tourist industry incited a building and construction boom – a kind of Ireland in the sun. Of course, it all went pear-shaped in the end.

In the fallout from the Credit Crunch of 2008 and the economic slowdown that ensued, a classic debt crisis evolved. First of all, the banks started to creek under the weight of massive doubtful exposures to real estate developers, commercial property value having fallen by 30% or more. Their resilience was further undermined by large exposures to Greek banks which had themselves begun to wobble after the Greek sovereign debt crisis, which exploded in May 2010. Their portfolios of Greek government bonds were given a haircut of up to 50% in 2011.

Then the Cypriot government became impecunious. As it became apparent that the Government lacked the necessary liquidity (money) to bail out its own banks, its bond yields soared. Its debt rating was finally downgraded to junk status by the rating agencies in March 2013, effectively disbarring it from raising new funds in the international debt markets.

In January 2012 Cyprus managed to secure a €2.5 billion loan from Russia on favourable terms. This was enough to keep the government going, but not enough to keep the banks afloat.

Finally, on 25 March 2013, a €10 billion international bailout by the Troika (the EU, The ECB and the IMF) was announced, but on draconian terms. First the government had to agree to close the country’s second-largest bank, the Cyprus Popular Bank (aka Laiki Bank) with bondholders being wiped out. Laiki Bank’s remaining assets were to be assumed by Bank of Cyprus. Second – and what was new about this bailout in comparison with previous bailouts for Greece, Ireland and Portugal – was that a one-off deposit levy of at least 6.75% was imposed on all uninsured bank deposits of over €100,000. An estimated 48% of uninsured deposits in the Bank of Cyprus (the island’s largest commercial bank), many held by wealthy Russians, were affected.

Depositors with large accounts in Laiki Bank were initially left with just €100,000 euros each, regardless of the amount they had on deposit. Those with more than €100,000 in the Bank of Cyprus lost access to 90% of their cash, although they have since been promised future access to some of their frozen funds. Under final terms announced on 30 July 2013 by the Central Bank of Cyprus, large depositors in the Bank of Cyprus were to have 47.5% of their money forcibly converted into shares, up from 37.5% in the original plan.

Some estimates suggest that up to €60 billion of bank deposits in Cyprus belonged, directly or indirectly to Russian corporations who had taken advantage of Cyprus’s emerging status as a tax haven. As a sop to wealthy Russians who had their fingers burnt, President Nicos Anastasiades has since decreed that anyone who lost more than €3 million is entitled to a Cypriot passport!

If the harshness of the Cyprus bailout was designed by the Troika to punish Cyprus for attracting “dirty Russian money”, the effect has actually been to bolster Russian influence in the country. The Bank of Cyprus is one of the EU’s systemically important financial institutions as defined by the Basel III framework; yet the percentage of this bank now owned by Russian interests has increased since the bailout as seized deposits are converted into shares. A leading oligarch, Dmitri Rybolovlev, already held a 10% equity stake in the Bank of Cyprus; but it now looks it looks like the Russians own more than 50%.

The Russian bear is also courting President Anastasiades. At issue is access for Russian warships to Cypriot ports and even a possible Russian military airbase near Paphos. Russia’s increased military presence in nearby Syria is much on people’s minds here.

It wasn’t only the Russians who were upset by a deal that was perceived locally as punitive. Better off Cypriots were outraged, inciting a lot of anti-EU sentiment.

How are things now? The crisis now seems like a bad dream. Cyprus’ economy is set to expand for the first time this year after three years in recession, as tough reform measures bear fruit. Following mild expansion in Q1, growth sped up notably in Q2 and recent indicators point to a robust performance for Q3. The IMF recently released the next tranche of the bailout deal and praised Cyprus’ good progress on reforms. It highlighted the country’s strong fiscal performance, higher-than-expected economic growth, the increased stability of the banking system and reduced exposure to Greece.

Meanwhile, the government has signalled that it plans to issue a 10-year bond of up to €1.5 billion before the end of this year in order to take advantage of favourable market conditions. Cyprus even became eligible for the ECB’s quantitative easing programme in July.

Time for a play on Cypriot banks? If zombie banks are your thing, take a look at the chart for Bank of Cyprus which you can access on the Frankfurt market (FRA:BC9N). It could be worth a punt: our Russian friends would surely not allow it to fail again.

And, oh yes, the olive harvest is going splendidly. First pressings are extremely encouraging. And, since you ask, the wine is not bad either.